I am working on my 2023 taxes and noticed that I over contributed above the roth 401k limit. I was missing a tax form and couldn't file by the deadline, so I submitted an extension.
Because I submitted an extension that gives me until October 15th to file, can I avoid being penalized on my roth 401k excess contributions if I take out the excess by that date?
I use Fidelity. What is the process for having them return the excess contributions for me? And will they automatically issue me a 1099-R for next year's taxes? Again, this is for excess roth 401k contributions.
"Because I submitted an extension that gives me until October 15th to file, can I avoid being penalized on my roth 401k excess contributions if I take out the excess by that date?"
No. The tax code specifies that deadline to receive the corrective distribution of an excess 401(k) employee contribution is April 15 of the following year, not the due date of your tax return for that year. See IRS IRB 2007-22: https://www.irs.gov/pub/irs-irbs/irb07-22.pdf
See IRS IRB 2007-22. There is no 10% penalty on excess employee contributions. The "penalty" is that the excess Roth contribution and attributable earnings will be taxable when eventually distributed even though the Roth contribution was not excludible from income, resulting in double taxation of the excess and taxation of the attributable earnings even if the distribution would otherwise be a qualified distribution. The excess and the attributable earnings will be the first amounts distributed when you do take a distribution from the Roth 401(k) and that amount will not be eligible for rollover.
No. All regular distributions are taxed only once. The double taxation results from the excess not having been excludible from income in 2023. You pay tax on that money (the excess) with your 2023 tax return and then again one time on that same money in the future when distributed.
"Because I submitted an extension that gives me until October 15th to file, can I avoid being penalized on my roth 401k excess contributions if I take out the excess by that date?"
No. The tax code specifies that deadline to receive the corrective distribution of an excess 401(k) employee contribution is April 15 of the following year, not the due date of your tax return for that year. See IRS IRB 2007-22: https://www.irs.gov/pub/irs-irbs/irb07-22.pdf
Thanks dmertz.
Are there any options for avoiding the penalty such as "moving" or repurposing the contribution for the following year (2024)? Or do I just need to take the 10% penalty and report the 1099-R on my 2024 tax return?
See IRS IRB 2007-22. There is no 10% penalty on excess employee contributions. The "penalty" is that the excess Roth contribution and attributable earnings will be taxable when eventually distributed even though the Roth contribution was not excludible from income, resulting in double taxation of the excess and taxation of the attributable earnings even if the distribution would otherwise be a qualified distribution. The excess and the attributable earnings will be the first amounts distributed when you do take a distribution from the Roth 401(k) and that amount will not be eligible for rollover.
When I finally take a distribution from my roth 401k, how will I know the final dollar amount that is to be double-taxed? I know how much I overfunded today, but how can I determine the attributable earnings after 20+ years?
I agree that figuring the attributable earnings over many years can be problematic. The IRS doesn't seem to have addressed this issue.
I called Fidelity today and they said something about a 6% penalty for every year that would be added to my tax liability as long as the excess contribution remains in my 401k. He didn't sound 100% confident though. Would that apply to my situation?
There is no 6% penalty. That penalty applies to excess IRA contributions, not to excess 401(k) contributions.
I looked up how to find out the earnings on a Roth 401K excess contribution, but all I found was the IRS net income attributable calculator, which seems to be for IRAs. But if this is the best tool I have, I'll use it.
To fix everything and simplify recordkeeping when I am retirement age, can I just withdraw the excess contribution now as an unqualified distribution, add it to my 2024 gross income, and pay the 10% penalty on the earnings? I didn't overfund by a lot, and I'd rather keep things simple when I retire.
The distribution will be a regular distribution. If you become eligible to take a distribution by separating from service before age 59½, the entire taxable distribution will be subject to the 10% early-distribution penalty. If you take the distribution after age 59½, there will be no early-distribution penalty.
You're saying if I withdraw the excess contribution now to fix this issue (I'm younger than 50), it will be a regular distribution and therefore not have an early withdrawal 10% penalty?
By "regular distribution," I mean not a return of contribution before the due date of your tax return. A regular distribution before age 59½ is an early distribution, not a normal distribution. Since you are under age 50 and not disabled or have any other penalty exception that would apply, a regular distribution will be subject to a 10% early-distribution penalty.
Thank you for the clarification dmertz.
Sorry to beat a dead horse. If I do a regular (early) distribution and take the 10% penalty now, can I avoid the double taxation on the initial distribution that is the amount of the excess withdraw and its earnings when I take a normal distribution after 59 and a half?
Because the excess was not corrected by April 15, 2024, the excess deferral is taxable on your 2023 tax return and does not create any basis in after-tax contributions in your 401(k). Assuming that you do nothing else to create basis in after-tax contributions in the 401(k), such as making explicit after-tax contributions (if the plan permits) or paying back a defaulted 401(k) loan, all of your regular distribution, early or normal, made in the future will be entirely taxable. The double taxation results from any regular distribution being taxable in addition to the excess being includible in income on your 2023 tax return. Nothing can be done to change that now.
"all of your regular distribution, early or normal, made in the future will be entirely taxable"
Are you saying that because I had a tiny amount of excess contribution from one year (2023), *all* regular distributions in the future from my Roth 401k (that has over $100,000 in it) will now be double-taxed?
No. All regular distributions are taxed only once. The double taxation results from the excess not having been excludible from income in 2023. You pay tax on that money (the excess) with your 2023 tax return and then again one time on that same money in the future when distributed.